Supreme Court Holds Statutory Exemption Language Inviolable

In a recent 9-0 opinion, Law v. Siegel, 571 U.S. ___ (March 4, 2014), the U.S. Supreme Court held that a bankruptcy court has no equitable authority to override statutory protections, reversing a Ninth Circuit decision allowing a bankruptcy trustee to surcharge a debtor’s exempt property to reimburse the trustee for fees incurred as a result of the debtor’s flagrant misconduct.

In the bankruptcy case below, the debtor owned property worth approximately $350,000, allegedly encumbered by two mortgages, each in the amount of approximately $150,000.  The debtor further claimed a homestead exemption of $75,000 under 11 U.S.C. § 522(d), leaving no equity in the property for the bankruptcy estate.

The trustee challenged the legitimacy of the second mortgage, and because of the debtor’s protracted vexatious actions, incurred $500,000 in legal fees proving that the second mortgage was, in fact, fraudulent.  In light of the inequitable conduct and based on existing Ninth Circuit precedent, the bankruptcy court granted the trustee’s motion to “surcharge” the entirety of the debtor’s statutory homestead exemption, making those funds available to defray the trustee’s attorney fees.

The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit both affirmed, holding that a bankruptcy court may surcharge a debtor’s statutory exemptions in exceptional circumstances, such as when a debtor engages in inequitable or fraudulent conduct.  Relying on 11 U.S.C. § 105(a), which provides statutory authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code, the lower courts held that the surcharge was proper because it was “calculated to compensate the estate for the actual monetary costs imposed by the debtor’s misconduct, and was warranted to protect the integrity of the bankruptcy process.”

The Supreme Court reversed.  Justice Scalia, writing for the unanimous Court, first held that the language of Section 522(d) provides no discretion to withhold the statutory exemptions provided therein on any grounds.  The Court further held that neither a bankruptcy court’s authority under Section 105(a), nor its inherent equitable powers, allow a court to contravene specific provisions of the Bankruptcy Code.  In other words, the Court held that a debtor’s misconduct does not authorize courts to fashion remedies incompatible with the debtor’s statutory rights.

The debtor’s “victory” on the exemption issue will likely be short-lived, however.  The Court noted that, notwithstanding its decision on the exemption issue, courts still have many tools for dealing with dishonest debtors, including denial of discharge; monetary sanctions under Rule 11; Section 105(a), or the court’s inherent powers; and referral for criminal prosecution.  On remand, the bankruptcy court may well impose sanctions against the debtor for his behavior, which as postpetition obligations will be enforceable through the normal procedures for collecting money judgments.

Takeaway:  The Law decision serves as a stark reminder to bankruptcy courts and trustees alike that courts have no equitable authority to deviate from unambiguous statutory exemption provisions, and the decision is clearly also applicable to any general actions that contravene specific statutory provisions.

A copy of the Law v. Siegel opinion can be found at http://www.supremecourt.gov/opinions/13pdf/12-5196_8mjp.pdf.

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