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Wednesday, March 5, 2014

Exemptions, Objections, and Law v. Siegel

Law v. Siegel  (U.S. Supreme Court opinion March 4, 2014)
Exemptions Safe From Bankruptcy Court’s “Adjustment”
Kevin C. McGee, Esq.
Partner
Seder & Chandler, LLP
Worcester, MA

            On March 4, 2014, the U.S. Supreme Court decided Law v. Siegel, on an appeal from the Ninth Circuit. The facts were that the Chapter 7 debtor (Stephan Law), in his bankruptcy schedules, stated the following: (1) he owned a California residence, which he valued at $363,348.00; (2) he had two liens on the residence, with a $147,156.52 first mortgage held by Washington Mutual Bank, and a $156,929.04 second mortgage held by “Lin’s Mortgage Associates”; and (3) he claimed a $75,000.00 California homestead exemption in the equity in the residence.

            Law’s Chapter 7 Trustee (Alfred H. Siegel) did not object to Law’s claimed homestead within thirty (30) days after Law’s meeting of creditors, as is required under Fed. R. Bankr. P. 4003(b)(1). However, Siegel did suspect that the second mortgage was not a legitimate debt, and started investigating. $500,000.00 in attorneys’ fees later, Siegel obtained an order invalidating the second mortgage as fraudulent. In addition, he petitioned the bankruptcy court to “surcharge” all of Law’s $75,000.00 exemption in the residence for Siegel’s attorneys’ fees (as permitted under 9th Circuit precedent). The bankruptcy court did so, on the basis that Law’s fraudulent and inequitable conduct permitted it to use 11 U.S.C. §105(a) to deny Law the fruits of his bad faith conduct.

            Judge Scalia delivered the unanimous decision of the Supreme Court justices. In his opinion, Judge Scalia held that neither the plain language of the bankruptcy exemption statute (11 U.S.C. §522), or the debtor’s bad faith actions, allowed a bankruptcy court to invalidate or surcharge an exemption for fees after the exemption had been allowed. He pointed out that, although several provisions in §522 either limit or prohibit exemptions in certain circumstances, §522(k) generally prohibits (with some narrow exceptions) the use of a debtor’s allowed exemptions for payment of administrative expenses, such as Siegel’s attorneys’ fees. In a quote sure to be repeated, he discounted the §105(a) argument as follows: "§522 does not give courts discretion to grant or withhold exemptions based on whatever considerations they deem appropriate.” Finally, he distinguished Marrama v. Citizens Bank of Mass., 549 U. S. 365 (2007) on its facts. In Marrama, the Supreme Court upheld a bankruptcy court’s denial of a Chapter 7 debtor’s motion to convert to Chapter 13. Siegel argued that Marrama supported the idea that a debtor’s bad faith could justify denying a debtor’s statutory right. Justice Scalia focused instead on whether, in Marrama, the debtor could have “qualified” for Chapter 13, and distinguished the case on that basis.


What does Law v. Siegel Mean to Debtors, Trustees and Bankruptcy Practitioners?

            First, it means that Chapter 7 trustees and creditors will need to make a more aggressive push, early in the case, either to object to exemptions or file a motion to extend the time to object to exemptions in order to provide enough time for investigation. Judge Scalia pinned a lot of his decision on Siegel’s failure to timely object to Law’s homestead exemption, and held that the consequence of that failure was that the exemption became ironclad and protected from future attack.

            Law v. Siegel also reaffirms – again – that the words and scheme used in the Bankruptcy Code have meaning and cannot be disregarded merely because a litigant or court wants to reach a result not intended by those words or that scheme. To this point, Judge Scalia wrote:

We acknowledge that our ruling forces Siegel to shoulder a heavy financial burden resulting from Law’s egregious misconduct, and that it may produce inequitable results for trustees and creditors in other cases. We have recognized, however, that in crafting the provisions of §522, ‘Congress balanced the difficult choices that exemption limits impose on debtors with the economic harm that exemptions visit on creditors.’… The same can be said of the limits imposed on recovery of administrative expenses by trustees. For the reasons we have explained, it is not for courts to alter the balance struck by the statute (citations omitted).


            The decision also means that debtors and their attorneys can rest easy once the exemption deadline passes – with one exception not noted in the decision. At the tail end of Law v. Siegel, Judge Scalia lists a variety of alternate means available to punish or sanction a debtor’s bad behavior: denial of a debtor’s discharge, sanctions under Fed. R. Bankr. P. 9011, criminal prosecution, and other unspecified sanction power under 11 U.S.C. §105(a). 

      He fails to mention, however, one path that will be open to trustees after Siegel and after 2008: Fed. R. Bankr. P. 4003(b)(2). That rule provides that a trustee may still file an objection to a debtor’s claim of exemption “at any time prior to one year after the closing of the case, if the debtor fraudulently asserted the claim of exemption.” Trustees who face similar issues as Mr. Siegel have "a second bite of apple" that was unavailable to Mr. Siegel. 


Quick Update
        
          I exchanged e-mails with Steven T. Gruber, Esq., who argued the case for Mr. Siegel. He pointed out to me that Fed. R. Bankr. P. 4003(b)(2) does not apply to his case, because Mr. Law filed his Chapter 7 case before the enactment of BAPCA and before the change in Rule 4003 (in 2008). He also told me that Mr. Law's discharge had been revoked, multiple civil sanctions had been assessed against him, and that Law moved all his personal property to China before he filed his bankruptcy case. There is also a criminal referral outstanding, but no one knows if it will ever proceed.

       Thanks to Mr. Gruber for taking the time to respond to my e-mails - as you can see, this was a very frustrating case and losing a Supreme Court case must be the equivalent of being on the losing side of the Super Bowl. The feelings are the same, whether you are a quarterback or a lawyer. 

©Kevin C. McGee