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Law Won

In Law v. Siegel, a case decided by the U.S. Supreme Court in March, the Court unanimously ruled that the bankruptcy court exceeded its authority when it surcharged the debtor’s homestead exemption to pay the Chapter 7 Trustee’s attorney fees, despite the debtor’s misconduct.

The case involved Stephen Law, a consumer debtor who filed for Chapter 7 bankruptcy in California. Law's only significant asset was his house, worth approximately $360,000. Law exempted $75,000 of the home equity under the state homestead exemption. Law further claimed that there was no additional equity in the house because it was subject to two mortgages totaling up to more than $300,000 — more than the nonexempt value of the house. The first mortgage was real. The second mortgage, allegedly in favor of "Lin's Mortgage & Associates,” was fake. Law was perpetrating a fraud. Alfred Siegel, the Chapter 7 Trustee, uncovered the mortgage scam. Unfortunately, in the process, the trustee incurred approximately $500,000 in legal fees.

To defray the legal fees, the trustee motioned the bankruptcy court to surcharge the $75,000 homestead exemption pursuant to its equitable powers under 11 U.S.C. § 105. The bankruptcy court granted the motion and surcharged the exemption to help pay the trustee’s legal fees. A Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed the decision on appeal.

The debtor, Law, argued that section 522(k) of the Bankruptcy Code expressly states that exempt assets are “not liable for the payment of any administrative expense” incurred during a bankruptcy. The trustee argued that administrative expenses should have a narrower meaning in section 522(k) (meaning his fees were not really administrative expenses), and that section 522 does not expressly prohibit denying an exemption based on bad behavior.

Justice Scalia, writing for the unanimous Court, ruled in Law's favor and reversed the Ninth Circuit, concluding that the bankruptcy court order at issue violated the Bankruptcy Code's exemption rules. Specifically, the Court stated that "whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code." The Court further noted that the Bankruptcy Code's "meticulous…enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exceptions.. . . [F]ederal law provides no authority for bankruptcy courts to deny an exemption on a ground not specified in the Code."

The Court recognized its ruling creates a financial burden for the trustee resulting from Law’s “egregious misconduct,” and that it may create inequitable results in the future for other trustees and creditors. However, the Court stated that there are other mechanisms to address Law’s misconduct. Specifically, the Court noted that “ample authority” exists to deny Law his discharge, sanction him for bad faith litigation conduct, or prosecute him under 11 U.S.C. § 152 for fraudulent conduct in a bankruptcy case.

The Court held that regardless of other sanctions available to impose upon the dishonest debtor, the bankruptcy court may not “contravene express provisions of the Bankruptcy Code by ordering the debtor’s exempt property to be used to pay debts and expenses for which that property is not liable under the Code.”

Law v. Siegel, 134 S. Ct. 1188 (2014).

Categories: Chapter 7, U.S. Supreme Court

Photo of Patricia J. Scott

 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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