Lead Opinion
Jаmes R. Nuckolls and Judy M. Nuckolls, a husband and wife trading as Jim’s and Judy’s Restaurant (the Nuckolls or debtors), appeal a district court judgment that they are not entitled to exempt certain equipment used in their restaurant business from their Chapter 7 bankruptcy estate and to avoid a security interest in the same equipment asserted by Dominion Bank of the Cumberlands, N.A. (the Bank). Prior to filing the bankruptcy petition, the debtors had recorded homestead deeds covering, among other things, the restaurant equipment at issue. After commencing bankruptcy proceedings the debtors filed in the bankruptcy court a complaint seeking a declaratory judgment as to the validity, priority, and extent of the Bank’s security intеrest. The bankruptcy court held that the Bank had failed to perfect its security interest by not filing a financing statement in both locations required under Virginia law, and that under the Bankruptcy Code, the debtors could exercise the power of the trustee to avoid unperfected security interests. On appeal by the Bank, the district court reversed, finding that the Bank’s security interest was enforceable against the debtors even though not perfected against
I.
During the fall of 1982 the debtors received two loans from the Bank, in the amounts of $2500 and $3500, the proceeds of which were used to purchase equipment and inventory for their restaurant business, Jim’s and Judy’s Restaurant of Grundy, Virginia. They made no repayments and in November 1982 received another loan in the amount of $7094.07 from the Bank. The proceeds of the November loan were used to pay off the earlier two loans and to provide them a cash amount of $1000. The debtors executed an agreement securing the November loan and pledged the restaurant’s inventory, equipment, accounts receivable, and cash as collateral. The debtors also signed a Uniform Commercial Code financing statement listing the same collateral. In the loan agreement the debtors waived any right to claim homestead exemptions under Virginia law as to the collateral.
Initially, the Bank filed the financing statement only in the Circuit Court of Buchanan County — not filing with the Virginia State Corporation Commission, as required by the Virginia UCC, until after thе debtors had filed their petition in bankruptcy.
On May 20, 1983, the debtors filed homestead deeds in Buchanan County, Virginia, claiming exemptions for, among other things, the restaurant equipment. On May 31, 1983, they filed a petition in bankruptcy. At the time of filing the petition, the debtors owed the Bank $8,857.22, representing the proceeds of the November 1982 loan plus interest.
II.
Under section 522 of the federal Bankruptcy Code, 11 U.S.C. § 522 (1982 & Supp. II 1984), a debtor may exempt certain property from the bankruptcy estate. The Bankruptcy Code defines the types of property exempt under federal law, but states are given the option to enact their own exemption schemes. 11 U.S.C. § 522(b)(2)(A), (d) (1982 & Supp. II 1984). Virginia has opted out of the federal scheme, so its statutory exemptions govern the Nuckolls’ bankruptcy case. Va.Code Ann. § 34-3.1 (1984). Under the Virginia scheme, each debtor is entitled to a homestead exemption. Virginia Code section 34-4 provides in part that “[ejvery householder or head of family residing in this State shall be entitled ... to hold exempt ... real and personal property, or either, to be selected by him, ... to the value of not exceeding $5,000.” Va.Code Ann. § 34-4 (1984). Each of the Nuckolls is entitled to a full $5,000 exemption under this provision. Cheeseman v. Nachman,
III.
Initially we must determine whether the exemption could be claimed in the absence of a waiver by the debtors. The Virginia statute provides that the homestead exemption of section 34-4
shall not extend to any execution order or other process issued on any demand ... [f]or the purchase price of such property or any part thereof. If the property*411 purchased and not paid for be exchanged for or cоnverted into other property by the debtor, such last named property shall not be exempted from the payment of such unpaid purchase money under the provisions of [section 34-4].
Va.Code Ann. 34-5(1) (1984). The Bank contends that this section deprives the debtors of the exemption, because the proceeds of the loan secured by the equipment were used indirectly to purchase the equipment.
The proceeds of the loan at issue here were not used to purchase the equipment. The proceeds repaid outstanding obligations and provided an additional cash advance to the debtors. The cases applying the section 34-5(1) exceрtion involve materially different facts. In each case a bankrupt purchaser of goods had failed to pay the price to the vendor of the goods, but still sought to exempt the goods from the estate under the homestead exemption. In re Tobias,
IV.
In the loan agreement, however, the Nuckolls expressly waived “the benefit of any homestead exemption to protect property from being used by [the Bank] to pay off the loan_” Under Virginia law such a waiver is enforceable against the debtor. Va.Code Ann. 34-22 (1984); White v. Owen,
Section 522(e) provides that
[a] waiver of an exemption executed in favor of a creditor that holds an unsecured claim against the debtor is unenforceable in a case under this title with respect to such claim against property that the debtor may exempt under subsection (b) of this section.
11 U.S.C. § 522(e) (1982 & Supp. II 1984). Without question the security agreement between the Bank and the debtors created a security interest in the еquipment in favor of the Bank valid under Virginia law. New Jersey Fidelity & Plate Glass Insurance Co. v. General Electric Co.,
Under the Virginia UCC, perfecting the security interest in the restaurant equipment required filing a financing statement in two locations: the office of the clerk of the court of Buchanan County, where the business was located, and the office of the State Corporation Commission. Va.Code Ann. 8.9-401(1)(c) (1965 & Supp.1984). The Bank promptly filed in Buchanan County, but neglected to file with the Corporation Commission until after the bankruptcy petition was filed. This failure strictly to comply with the statute leaves the security interest in the equipment unperfected as against third parties. In re Mauck,
A filing which is made in good faith in an improper place or not in all of the places required by this section is ... effective with regard to collateral covered by the financing statement against any person who has knowledge of the contents of such financing statement.
Va.Code Ann. 8.9-401(2) (1965 & Supp. 1984). According to the Official Comment to this subsection, “filing in only one of the two required places is not effective except as against one with actual knowledge of the contents of the defective financing statement.” Id. Official Comment, at 202. The debtors signed the financing statement at the time the November loan was executed. Because they then had actual knowledge of the contents of the financing statement, the Bank’s security interest was perfected as to them. Because section 522(e) of the Bankruptcy Code applies only to waivers of exemptions involving “an unsecured claim against the debtor,” it is unavailable to the debtors here.
V.
We conclude, however, that under section 522(f) the debtors may avoid the Bank’s lien despite their waiver of the homestead exemption. Subsection (f) provides in pertinent part that:
[notwithstanding any waiver of exemptions, the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsеction (b) of this section, if such lien is ... a nonpossessory, nonpurchase-money security interest in any ... implements, professional books, or tools, of the trade of the debtor.
11 U.S.C. § 522(f)(2)(B) (1982). A debtor may use this subsection to avoid liens on property over which he claims an exemption even if he had previously agreed to create the lien by granting to the creditor/lienholder a security interest in the property. Hall v. Finance One of Georgia, Inc. (In re Hall),
The language of the statute is straightforward — the avoiding power applies “[notwithstanding any waiver.” 11 U.S.C. § 522(f). We think that section 522(f) thus remains effective despite a waiver of the homestead exemption. Statements in the lеgislative history of the Bankruptcy Reform Act of 1978, Pub.L. No. 95-598, 92 Stat. 2549 (codified as amended at 11 U.S.C. §§ 101-151326 (1982 & Supp. II 1984)), lend support to this conclusion. As the Eleventh Circuit has summarized:
Congress evidenced its concern about over-reaching creditors who obtained nonpossessory, nonpurchase-money security interests covering a substantial part of debtors’ otherwise exempt property. Congress found that debtors usually granted blanket security interests, and agreed to waive their right to exempt property, without understanding the consequences of their actions. The property subject to these liens often was of little value to the creditors, because of its low resale value, but its replacement cost to debtors was usually high. Accordingly, creditors, although they did not view the property as a source of funds to which they could turn in the event of default, often used the threat of foreclosure to coerce debtors into making payments. Under section 522(f), debtors can now protect themselves from this practice by avoiding these liens in bankruptcy.
Hall v. Finance One of Georgia, Inc. (In re Hall),
protects the debtor’s exemptions, his discharge, and thus his fresh start by permitting him to avoid certain liens on exempt property. The debtor may avoid a judicial lien on any property to the extent that the property could have been exempted in the absence of the lien, and may similarly avoid a nonpurchase-mon-ey security interest in certain household and personal goods. The avoiding power is independent of any waiver of exemptions.
S.Rep. No. 989, 95th Cong., 2d Sess. 76 (1978), reprinted in 1978 U.S.Code Cong. & Ad.News 5787, 5862. Although the focus of congressional concern appears to have been contracts of adhesion covering consumer goods, the statute is not so limited. The debtor’s knowledge of or intent to grant the security interest or waiver of exemption sought to be avoided is irrelevant, and the statute expressly covers property other than household goods. See Augustine v. United States,
We have discovered dicta but no direct holdings to suppоrt this result. In In re Caldwell,
Our final task is to determine whether the restаurant equipment at issue here is the type of property covered by section 522(f). Despite the Bank’s assertion to the contrary, the lien it holds is a “nonposses-sory, nonpurchase-money security interest” under section 522(f)(2). It is not a purchase-money lien, because it secures a loan made to refinance a pre-existing debt—not to acquire the collateral. The “refinancing or consolidating loans by paying off the old loan and extending a new one extinguishes the purchase money character of the original loan because the proceeds of the new loan are not used to acquire rights in the collateral.” Matthews v. Transamerica Financial Services (In re Matthews),
An unresolved question remains as to whether all of the restaurant equipment constitutes “implements ... or tools, of the trade of the debtor” so as to warrant application of 11 U.S.C. § 522(f)(2)(B). Although no test has emerged, the standard applied by the courts appears to be whether the items are “specifically suited” to business use, In re Meany,
The judgment of the district court is, therefore, reversed and the case remanded to the district court with instructions to remand it to the bankruptcy court for further proceedings consistent with this opinion.
REVERSED AND REMANDED.
Concurrence Opinion
concurring specially:
Although I agree that the majority opinion correctly applies the current law of bankruptcy exemptions, I feel compelled to comment on the state of that law. This area of the law is, in a word, imperfect. And, while perfection may bе impossible to obtain in bankruptcy legislation as in all other human endeavors, one would have expected the Bankruptcy Reform Act of 1978 (“the BRA”)
Section 522 of the BRA, its exemption provision, is in many ways an odd creation. The section reflects conflicting policies, particularly in’ the pivotal subsection (b). Called the “opt-out” provision, this subsection allows states to choose their own exemption schemes by vetoing the federal scheme set out in subsection (d), a situation that has been characterized as “one of the most peculiar federal-state arrangements on record.” Prendergast, State Secrets, Nat’l L.J., Apr. 30, 1979, at 8, col. 1. Over seventy percent of the states have enacted legislation choosing their exemption schemes over the federal one.
If lawmaking is like sausage-making, section 522(b) is a rare piece of sausage. The policies reflected in the section are conflicting because it resulted from an eleventh-hour compromise between the House and the Senate.
The compromise of section 522(b) has been criticized widely. See, e.g., articles cited supra note 3; see also Note, The Failure of the Virginia Exemption Plan, 21 Wm. & Mary L.Rev. 851, 876-80 (1980) (criticizing the Virginia legislature for opting out) [hereinafter Note, Failure of Virginia Plan ]. The criticism most often repeated is that the nonuniformity created by section 522(b) frustrates the fresh-start policy at the heart of the bankruptcy laws. See Haines, supra note 3, at 9, 41-43; Rendleman, supra note 3, at 651-52; Vuko-wich, supra note 3, at 801-04; see also Note, Failure of Virginia Plan, at 878 (Virginia’s opt-out legislation hinders rehabilitation of debtors). Furthermore, the constitutionality of section 522(b) has been challenged not only on the ground that it fails to satisfy the constitutional mandate for Congress to enact “uniform [l]aws” governing bankruptcies, but also on the ground that it represents an impermissible delegation of congressional power.
Because a statute is constitutional, however, does not necessarily mean that it is either sensible or effective. The criticism of section 522, in other words, is justified, although not merely for the pro-federal policies that the commеntators have voiced. Enactment of the opt-out mechanism would seem to represent congressional deference to state exemption schemes, even at the expense of federal fresh-start policy. See Haines, supra note 3, at 8. Assuming the wisdom of this deference, one must doubt Congress’ sincerity after reviewing the current operation of section 522 in Virginia. The debtors in this case, for instance, each are given a full $5,000 exemption under the Virginia homestead exemption even though, as defined by state law, the exemption is limited to a “householder,”
Modifying state law to fit its perceived goals of the bankruptcy laws, this Court in Cheeseman read Virginia’s definition of “householder” to include a husband and wife living together even though arguably
In contrast with the result in Cheeseman is a decision of this Court interpreting the relationship between subsection 522(i)
Yet invocation of section 522(f)’s lien-avoidance provision, as the debtors have done in this case, offers another example of the frustration of, rather than deference to, Virginia’s exemption scheme. When the Nuckolls sought and received their loans from Dominion Bank, they signed an agreement waiving any right to claim homestead exemptions under Virginia law. Now embodied in Va.Code section 34-22 (1984), the homestead waiver has been part of Virginia’s exemption scheme since the first enactment of the homestead exemption in 1870. See Act of June 27, 1870, ch. 157, 1869-70 Va.Acts 198 (first codified at Va.Code ch. 183, § 3 (1873)). Until a revision of the Constitution of Virginia that became effective July 1, 1971, the waiver was authorized by sections 190-193 of the Constitution of 1902 as well as by statute. Two cases decided under the 1873 codification of the homestead provisions recognized that the waiver helped to give debtors the economic mobility necessary for them to provide for the best interests of themselves and their families. See Linkenhoker’s Heirs v. Detrick,
Section 522(f) seems to leave little doubt, however, that waivers of exemption are unenforceable. The section begins “Notwithstanding any waivers of exemptions. ...” 11 U.S.C. § 522(f) (1982). Pertinent legislative history indicates that “[t]he avoiding power is independent of any waiver of exemptions.” H.R.Rep. No. 95-595, 95th Cong., 1st Sess. 361-62, reprinted in 1978 U.S.Code Cong. & Ad.News 6318. Some courts have decided that state law can limit debtors’ lien-avoidance powers,
Notes
. Pub.L. No. 95-598, 92 Stat. 2549 (codified at 11 U.S.C. §§ 101-151326 (1982)).
. See Ala.Code § 6-10-11 (Supp.1985): Alaska Stat. § 09.38.055 (1983); Ariz.Rev.Stat.Ann. § 33-1133 (Supp.1984-1985); Ark.Stat.Ann. § 36-210 (Supp.1985); California Civ.Proc.Code § 703.130 (West Supp.1985); Colo.Rev.Stat. § 13-54-107 (Supp.1984); Del.Code Ann. tit. 10, § 4914 (Supp.1984); Fla.Stat.Ann. § 222.20 (West Supp.1985); Ga.Code § 44-13-100(b) (1982); Idaho Code § 11-609 (Supp.1985); Ill. Ann.Stat. ch. 110, § 12-1201 (Smith-Hurd 1984); Ind.Code Ann. § 34-2-28-0.5 (Burns Supp. 1984); Iowa Code Ann. § 627.10 (West Supp. 1985); Kan.Stat.Ann. § 60-2312 (Supp.1984); Ky.Rev.Stat.Ann. § 427.170 (Baldwin Supp. 1984); La.Rev.Stat.Ann. § 13-3881 (West Supp. 1985); Me.Rev.Stat.Ann. tit. 14, § 4426 (Supp. 1984-1985); Md.Cts. & Jud.Proc.Code Ann. § 1 1-504(g) (1984); Mo.Ann.Stat. § 513.427 (Vernon Supp.1985); Mont.Code Ann. § 13-2-106 (1984); Neb.Rev.Stat. § 25-15,105 (Supp. 1984); Nev.Rev.Stat. § 21.090(3) (1983); N.H. Rev.Stat.Ann. § 511:2-a (1983); N.Y.Debt. & Cred.Law § 284 (McKinney Supp.1984-1985); N.C.Gen.Stat. § 1C-1601(f) (1983); N.D.Cent. Code § 28-22-17 (Supp.1983); Ohio Rev.Code Ann. § 2329.66(A)(16) (Page 1984); Okla.Stat. Ann. tit. 31, § 1(B) (West Supp.1984-1985); Or. Rev.Stat. § 23.305 (1983); S.C.Code Ann. § 15-41-425 (Law.Co-op Supp.1984); S.D.Comp.Laws Ann. §§ 43-31-30, -45-13 (1983); Tenn.Code Ann. § 26-2-112 (1980); Utah Code Ann. § 78-23-15 (Supp.1985); Va.Code § 34-3.1 (1984); W.Va.Code § 38-10-4 (1985); Wyo.Stat. § 1-20-109 (Supp.1985).
The following fourteen states have not opted out at this date: Connecticut, Hawaii, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, New Mexico, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.
.See generally Haines, Section 522’s Opt-Out Clause: Debtors’ Bankruptcy Exemptions in a Sorry State, 1983 Ariz.St.L.J. 1, 5-10; Rendleman, Liquidation Bankruptcy Under the ’78 Code, 21 Wm. & Mary L.Rev. 575, 650-52 (1980); Vukowich, Debtors’ Exemption Rights Under the Bankruptcy Reform Act, 58 N.C.L.Rev. 771, 772-75, 803-04 (1980).
. Both of these constitutional challenges were rejected by the United States Court of Appeals for the Seventh Circuit in a recent case. See In re Sullivan,
. "The word 'householder' as used in this title shall include any person, married or unmarried, who maintains a separate residence or living quarters, whether or not others are living with him.” Va.Code § 34-1 (1984).
.See Cheeseman,
In a recent decision, the United States Court of Appeals for the Ninth Circuit expressly rejected the reasoning of Cheeseman. See In re Granger,
Some commentators have argued that Virginia’s definition of "householder” should be revised. See, e.g., Ulrich, supra, at 153 & n. 149; Comment, In re Cheeseman; A Judicial Revision of Virginia’s Homestead Exemption Laws, 16 U.Rich.L.Rev. 391, 402-04 (1982) (urging the Virginia legislature to validate the interpretation of "householder" in Cheeseman by having the definition apply to both spouses, even when they live in the same house). Despite the calls for revision, the Virginia legislature has seen fit to retain the present scheme. A revision with which the legislature did agree, however, was an increase in the amount of the exemption from $3,500 to $5,000, which it enacted in 1980. Act of March 17, 1980, ch. 167, 1980 Va.Acts 191 (codified at Va.Code § 34-13 (1984)).
. In 1984, Congress amended subsection 522(m) to read as follows: "Subject to the limitation in subsection (b), this section shall apply separately with respect to each debtor in a joint case.” The Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub.L. No. 98-353, § 522(m), 98 Stat. 353, 375 (1984). The "limitation in subsection (b),” also added by the 1984 amendments, prevents one spouse in a joint case from claiming one type of exemption scheme — state or federal — while the other spouse claims the alternative type of scheme. See id. § 522(b). These amendments do not affect the decision in Cheeseman because, of course, Virginia’s opt-out legislation gave the debtors no choice but to claim the state exemption scheme, which they did.
. Section 522(1) provides as follows:
The debtor shall file a list of property that the debtor claims as exempt under subsection (b) of this section. If the debtor does not file such a list, a dependent of the debtor may file such a list, or may claim property as exempt from property of the estate on behalf of the debtor. Unless a party in interest objects, the*417 property claimed as exempt on such list is exempt.
11 U.S.C. § 522(1) (1982).
. The decisions allowing state law to limit debtors’ lien-avoidance powers, in spite of section 522(f)’s language and legislative history, have done so by relying on subtle definitions of state law. See Giles v. Credithrift of America, Inc. (In re Pine),
. See note 10 on page [150].
. Congress, on the one hand, articulated a policy protecting a debtor's fresh start by enabling him to avoid nonpossessory, nоnpur-chase-money security interests in exempt necessities while, on the other hand, declared deference to state exemption statutes which could preclude operation of lien avoidance powers, by eliminating exemptions in the presence of liens. Congress utterly failed to recognize the problem.
Haines, supra note 3, at 30. Legislative history, moreover, fails to illuminate the interrelationship between section 522(f) and the opt-out clause. Id. at 30 n. 179.
. See generally Rendleman, supra note 3.
. Previously, legislation has been introduced as a response to recognized problems with section 522. Dubbed the Bankruptcy Improvement Act of 1981, this legislation not only would have eliminated the substantive federal exemptions in subsection (d), leaving only state exemptions to apply in bankruptcy, but also would have removed lien-avoidance powers regarding non-possessory, nonpurchase-money security interests. S. 2000, 97th Cong., 1st Sess. § 7(b), (c) (1981). Similar legislation introduced in the House also would have removed the lien-avoidance powers regarding nonpossessory, nonpur-chase-money security interests. H.R. 7294, 97th Cong., 2d Sess. § 305(b) (1982).
The appropriateness of such measures is arguable. The measures, in any event, may miss the point. Ensuring that bankrupts only can claim exemptions under state schemes would reflect greater deference to state law than is already shown with the opt-out mechanism, yet the effect of other subsections in section 522 still could undercut the effectiveness of the state schemes.
Removing lien-avoidance power regarding nonpossessory, nonpurchase-money security interests, on the other hand, would be more consistent with the deferential spirit of the opt-out provision and might therefore lead to a more coherent exemption scheme. As already shown, however, lien avoidance is not the only way that state exemption schemes can be distorted in bankruptcy proceedings. In the final analysis, Congress may be forced to rework the entire scheme of bankruptcy exemptions. Before doing so, it should consider what it is trying to accomplish by meshing state and federal law. Otherwise, it may contribute to the confusion over section 522 or, at the least, trade old problems for new ones.
. Biographia Literaria ch. 1 (1917).