Mansion Loophole in Bankruptcy Laws Targeted

The Enron Corp. debacle is increasing pressure on lawmakers to close a loophole in the nation’s bankruptcy code that allows millionaires in Texas, Florida and several other states to declare bankruptcy--and keep their mansions.

From the start, the federal bankruptcy laws have included some exemptions set by the states. Bankrupt homeowners in many states are allowed to keep a basic dwelling. However, five states--Texas, Florida, Iowa, Kansas and South Dakota--set no limit on how much can be shielded through this “homestead exemption.”

Thanks to this rule, lavish spenders, scam artists, stock promoters and failed business tycoons can maintain opulent homes while escaping their legal debts.

Florida and Texas, in particular, have been known as havens for celebrities and the formerly wealthy who have gone broke. They have included actor Burt Reynolds, corporate raider Paul Bilzerian, former baseball commissioner Bowie Kuhn and, most recently, O.J. Simpson.

Now Senate Democrats are raising the prospect that this Texas-style exemption will shield Enron’s executives from the harsh consequences of bankruptcy.

If former Enron Chief Executive Kenneth L. Lay declares bankruptcy to shield himself from creditors, “the Texas homestead law will allow him to keep an unlimited amount of equity in his 13,000-square-foot Houston penthouse, valued at $7.1 million,” Sen. Herbert Kohl (D-Wis.) said Wednesday. “There is no justice in a system that puts thousands of people on the street without a job and wondering about their rent but that helps perpetrators live in multimillion-dollar homes.”

Congress has been moving to tighten the bankruptcy laws and has targeted individuals who seek to escape from their credit card debts. But lawmakers have disagreed on whether the crackdown should extend to wealthy homeowners in the states with the unlimited homestead exemption.

Last year, the Senate adopted an amendment sponsored by Sens. Kohl and Dianne Feinstein (D-Calif.) that would set a uniform $125,000 homestead exemption as part of the bankruptcy reform bill. They argued that those who seek the protections of the federal bankruptcy system should play by the same rules, whether they live in California, Wisconsin or Texas.

But the House refused to scrap the open-ended homestead exemption in its version of the bill, and the issue has emerged as the key point of dispute in the legislation. Lawmakers from the two houses have met in a conference committee but have not worked out their disagreements.

Both Democrats and Republicans from Texas and Florida have resisted the change. Sen. Bob Graham (D-Fla.) said it would upset “the whole principle of federalism” to impose a uniform national rule in the bankruptcy code. Sen. Kay Bailey Hutchison (R-Texas) vowed to “try and kill the bill” if it removes Texas’ unlimited homestead exemption.

Staff aides also say House Majority Leader Dick Armey and House Majority Whip Tom DeLay, both Texas Republicans, have strongly opposed the change.

President Bush, a former Texas governor, has also taken an interest in the issue.

In 1998, he spoke out against an earlier move in Congress to end the special exemption in Texas as a “clear violation of states’ rights.”

And last year, after the Senate approved the Kohl-Feinstein amendment, the White House sent a letter to lawmakers urging them to preserve the state-by-state rule.

But the bankruptcy of what was the nation’s seventh-largest corporation has revived support for changing the rules.

“The Enron demise underscores the need for a nationwide cap on the homestead exemptions,” Senate Judiciary Committee Chairman Patrick J. Leahy (D-Vt.) said Wednesday. Texas executives should not be allowed to use their special homestead exemption “to shield an unjust enrichment from defrauded investors.”

In California, bankrupt individuals can shield only $50,000 of equity in a residence, while families can shield $75,000, said UCLA law professor Kenneth Klee, an expert on bankruptcy law.

“I think the unlimited exemptions puts the entire system into disrepute,” Klee said.