Being in the cross-hairs of a client’s legal malpractice claim is a horrible-enough experience for any lawyer. Even worse would be if your house had to be sold in order to satisfy the former client’s default judgment against you, as the Seventh Circuit ordered in a case earlier this month. The opinion spotlights how state law impacts the bankruptcy code when it comes to protecting a residence from bankruptcy creditors — including those who might have a judgment against you.
Tenants in the entirety
According to the Seventh Circuit’s opinion, a client hired an Illinois lawyer to file a medical malpractice claim on her behalf, but the statute of limitations expired before the lawyer filed suit. The client sued for legal malpractice, obtained a default judgment, and recorded it against property that the lawyer and his wife owned as tenants by the entirety. The client claimed that with post-judgment interest, her claim against the lawyer totaled more than $1 million.
In 2015, the lawyer sought bankruptcy protection as a result of his own financial issues and filed a chapter 7 voluntary petition for relief. In his bankruptcy schedules filed with the court, the lawyer identified his debt to the former client and acknowledged that it was secured with a judgment lien on his residence. At the petition date, the lawyer and his wife owned the property as tenants in the entirety; but prior to receiving a discharge order in the bankruptcy, the wife died.
Under Illinois law, the tenancy by the entirety ended when the wife died, and the lawyer’s interest became an individual one, in fee simple.
In the bankruptcy court, the lawyer argued that his residential property was exempt from the client’s lien under 11 U.S.C. § 522(b)(3)(B). The Bankruptcy Code section exempts from the bankruptcy estate property in which the debtor has an interest as a tenant by the entirety “to the extent that such interest … is exempt from process under applicable non-bankruptcy law.”
The lawyer argued in the bankruptcy court that his contingent future interest in the home while his wife was alive was sufficient to keep it out of his Chapter 7 estate. Tracing the tenancy-by-the-entirety doctrine back to the English feudal system, and reversing the bankruptcy court, the Seventh Circuit rejected the argument.
The court noted that tenancy in the entirety is a form of ownership originating before married women had legal identities and property interests of their own. The doctrine enabled spouses to own property jointly, which would belong to the survivor when one spouse died. But once women could hold property in their own right, states “splintered in their approach to tenancy the entirety,” the court said.
The Bankruptcy Code requires a state-by-state analysis, the court pointed out — and Illinois law, unlike that of some states, mainly provides protection against a forced sale of the property to collect a debt against only one of the tenants. “Illinois law does not make all interests held by tenants in the entirety immune from process,” the court said, citing section (1)(c) of the Illinois joint tenancy statute, and fails to provide an exemption for contingent future interests such as the lawyer claimed.
In contrast to the law of Illinois, the court pointed to neighboring Indiana. Under the Hoosier State’s statutes, “any interest the judgement has in real estate as a tenant by the entireties” is immune from bankruptcy process, noted the court.
We hope that you’ll never be in a legal-malpractice mess or a bankruptcy situation, let alone both. But if you are, get expert help on the nuances of state law and how it affects your exemptions and interests in property — the home you save could be your own.